Wednesday, September 12, 2007

Is HKEx a Public Body or Private Club?

It was the crack of dawn on Tuesday, October 20, 1987 in Hong Kong. The U.S. stock market had tanked more than 22 percent on Monday. Inside Financial Secretary Piers Jacobs’ residence the clang of the wailing phone shattered the morning silence. The caller at the other end was Ronald Li, patriarch of The Stock Exchange of Hong Kong, an amalgam of four previously independent stock exchanges. What happened afterwards is history.

It was only in the previous year that the four independently owned and managed stock exchanges in Hong Kong had been merged into one single entity governed by one set of rules and regulations, in order to project a better image of Hong Kong being a free market-oriented and properly regulated international financial center. In those unruly pre-unification days when insider trading had been the norm rather than the exception, the four exchanges had often been accused of being run as private clubs by self-serving, vested interest groups, at the expense of small investors on the street.

Those four exchanges were: the Hong Kong Stock Exchange which was the colonial legacy, the Far East Exchange which was owned by Ronald Li, cousin of Bank of East Asia chairman David Li, the Kam Ngan Stock Exchange which belonged to gold dealing guru Woo Hon Fai, and the Kowloon Stock Exchange which was run by a commodity trader.

But on that fateful day, the ideals of the unification of the stock exchanges were utterly defeated. The image of Hong Kong as having a free market was ruined as the stock and index futures markets were arbitrarily ordered to close for four days, not so much for the credulous purpose of diffusing the shock to investors from the U.S. fallout as for the self-serving reason of attempting to limit losses on huge shareholding positions of interested parties. Unfortunately, rather than showing an orderly decline as desired, both the stock and index futures markets went into a freefall when the markets reopened on October 26, plunging 33 percent. Massive defaults by futures brokers followed and the futures exchange clearing house collapsed, bringing down with it the futures exchange and Hong Kong’s international reputation.

The irony is the 4-day closure of the markets, rather than helping to mitigate price falls as intended, only served to exacerbate the already jittery nerves of punters and max out the subsequent share dumping and index futures shorting.

Amidst fierce criticisms by international stock and futures brokers of the four-day market-shut-down interventionist move which was deemed obnoxious in a free economy like Hong Kong, culprits (or scapegoats, depending on who’s telling the story) were named and punished. The catastrophe led to the establishment of the watchdog body, the Securities and Futures Commission. The colonial government also appointed Sir Wilfrid Newton, then ex-chairman of the MTRC and an expert on financial crisis management, to start restructuring the futures exchange and its clearing operations.

The major lesson from the 1987 carnage seems to be that equity markets are best left to their own forces provided that appropriate regulatory mechanism is in place. But the HKSAR government has often found it hard to leave stock markets alone, albeit often declaring itself a devout disciple of free market principles.

Still fresh in people’s memory is the government’s 1998 share-buying spree, using HK$118 billion of Hong Kong people’s money without so much as the slightest intention of consulting them first.

Now we’ve been told that the SAR government already owns 5.88 per cent of Hong Kong Exchanges & Clearing (HKEx), which makes it the single largest shareholder and a “minority controller” of the public organization, along with five others. It is not known whether the buying act will continue, but the share price of HKEx has already spiked up 17 percent since the announcement last Friday. Besides, according to David Webb, the corporate governance expert, it also owns through the Exchange Fund HK$150 billion worth of Hong Kong equities, or equivalent to 3.2 per cent of the free float of each company in the Hang Seng Index, making it the second largest investor in Hong Kong stocks.

There are talks about the SAR government planning to merge HKEx partially with the Shanghai Stock Exchange. Hence its scrambling to seize control of HKEx is probably because it wants to ram the plan through without any unnecessary struggle.

We have certainly come a long way from the days of insider trading, but with the government getting its hand deeper and deeper into Hong Kong’s stock market, it begs the questions of how free, or how planned, our economy really is, how much of an “insider” the government wants to become and, most importantly, whether HKEx is going to be run more and more like government’s private club with little accountability to the public.